Sunday, 29 November 2009

How not to write about inheritance tax

Andrew Rawnsley has an excellent article in today's Observer on the changing politics of inheritance tax. George Osborne's pledge in 2007 to raise the threshold for the tax to £1m was very popular and pushed Labour on to the back foot, so much so that Labour followed with its own move to raise the threshold from £325,000 to £650,000 (for couples). (Quite why only children with coupled parents should benefit from a rise in the threshold was never explained.) But now, in the era of deficits and looming austerity, the Conservative pledge looks less canny, as if the one group that the Conservatives can find some tax relief for in these difficult times are the very rich.

The Observer's Political Editor, Toby Helm, also reports that, in view of the changed circumstances, the government is considering freezing the threshold at £325,000/£650,000, rather than increasing it as planned to £350,000/£700,000.

This would seem to me to be the least the government could do as part of a program for spreading the burden of paying for valuable public services in what are indeed difficult times.

But consider how Toby Helm chooses to describe the issue:

'Homeowners hoping to be freed from crippling levels of inheritance tax could be hit by new austerity measures...'

'...he [Alistair Darling] is considering freezing the threshold at which the tax becomes payable....This means that, if property prices rose, more -not fewer - householders will be liable to pay the 40% tax.'

Let's start with that phrase 'the 40% tax'. The 40% in question is, of course, the marginal rate of tax paid on everything above the tax threshold. So if the threshold is £325,000, and you inherit £400,000, then you would pay 40% on £75,000 - a tax liability of £30,000 on £400,000. So, in this case, the '40% tax' would actually be a 7.5% (3/40) tax.

As a matter of maths, nobody, but nobody, will actually pay 40% of what they inherit in tax because no tax is paid on the amount below the threshold. And the majority of estates which pay tax will probably pay a much smaller proportion than 40%. So referring to it as 'the 40% tax' is misleading. It risks fuelling the misperception that, once the threshold is breached, you pay 40% on the whole estate.

Bearing this in mind, let us now consider the article's opening reference to 'crippling levels of inheritance tax.'

It is not clear to me that even if people inheriting, say, £325,000, were paying 40% tax on the whole lot this would constitute 'crippling' taxation. To retain 60% of an unearned capital transfer in excess of £300,000 strikes me as still a handsome chunk of change which many people would be grateful for.

But as I have just pointed put, the actual level of tax is typically much, much lower than 40%. As noted, a person inheriting £400,000 would pay just £30,000 in tax. 'Crippling'? Bear in mind that this is much lower than the tax you would pay if the £400,000 was earned income.

Am I skewing things unfairly by focusing on the £400,000 case (rather than focusing on a really large inheritance)? No, not so far as Helm's article is concerned. For his point is that if the threshold is not raised, then 'more - not fewer - householders will be liable to pay the 40% tax.' But those who consequently just come in over the threshold will only be just over it. And so, as the above example shows, they will pay a very low level of tax.

More exactly, consider those (single people) who would otherwise not pay tax if the threshold were raised to £350,000. They will pay tax because their estate, while less than or equal to the proposed new threshold of £350,000, is above the existing threshold of £325,000. So the maximum amount they will pay tax on is £25,000. They will pay 40% of that: a maximum of £10,000. So they will pay £10,000 on an inheritance of, say, £350,000, a tax of less than 3% of the total they inherit.

It is a rather peculiar use of the English language to describe a tax of 3% as 'crippling'.

The sort of language Helm uses, while a million miles from the reality of the tax, is what I would expect to see in the right-wing press. For although the language bears little relation to reality, they have a tax-cutting political agenda, after all, and an interest in fuelling the kind of misperceptions and misunderstandings that phrases like 'the 40% tax' and 'crippling taxation' promote.

But Helm is not obliged, as a writer for The Observer, to promote this political agenda.

Take two 1970's East End council house residents. Let's call them Mr Squire and Mr Tennant.

Mr Squire buys his home in the 80's. Mr Tennant chooses not to (he and his wife have two nice holidays every year instead of paying a mortgage).

They both retire and die, willing everything to their children all of whom have recently left school, and are unemployed and living at home.

Their homes are now worth £750K each.

Mr Tennant's children get to stay in their home - they don't even have to pay any rent any more. They don't have to pay any extra tax because their parents spent their money on consumable products, rather than striving to escape state dependency.

Mr Squire's kids are not so lucky. The state says they must come up with £40K in ready notes just to stay put. (The law says there is no CGT due on gain in a primary residence's value, but hey...). They have to move house, losing more value to: HIP; Estate Agent; Removal Co.; Conveyancer; SDLT (e.g. £25K - HMRC takes another £30K from the buyer of their old home). HMRC takes a total of £95K.